Banking & Finance

Trust deficit

Regulator gets tough on trust-lending

Not amused: CBRC’s Liu Mingkang

When China’s banking regulator, the CBRC, undertook a major overhaul of the trust sector in 2007, it published a clear mission statement on its website. The plan? “To encourage trust companies to reorganise and innovate based on the needs of the market”. The intention was two-fold; to improve competitiveness and bolster risk management across the industry within five years.

Three years later and China’s trust companies have certainly employed creative methods to meet the market’s requirements. The problem is that the CBRC is now so spooked by the dealings between trusts and banks that it has ordered a clampdown on one of the most lucrative operations – an activity that has become known as trust-lending.

Trust-lending is when a bank removes a loan from its balance sheet by selling it on to a trust company, which in turn repackages it and sells it to investors as an investment product. Back in March (see WiC53) this publication predicted that such practices could lead to serious problems for the financial sector.

It all sounds a little familiar, with echoes of the sub-prime free-for-all that led to Chinese tut-tutting at the recklessness of the Western financial world.

It only becomes a problem, of course, if the system is abused. Until a few years ago these loans were insignificant in scale. But now their total outstanding balance amounts to Rmb2.9 trillion ($339 billion), reports the Financial Times. In the first half of this year alone, Rmb1.3 trillion of such loans were issued. And since this off-book debt does not count towards a bank’s lending quota, or affect its capital adequacy ratio, it can also hide the genuine level of risk that the banking sector is exposed to.

The CBRC has had enough. Last week, the regulator informed banks that they need to put all the loans they have sold to trust companies back on their books. There was a further demand that the banks stop using them to skirt regulatory requirements (the suspicion is the banks are circumventing lending limits policymakers have set to cool the economy).

“We’ve learnt the lesson of the financial crisis and we realise we need to strengthen oversight over this phenomenon,” a senior regulator told the FT, alluding to the securitisation problems that brought down the global financial system in 2008.

The action comes one month after the regulator started conducting stress tests on trust companies, and aligns with government efforts to rein in credit in general.

“It’s a positive move toward ensuring financial sector stability over the medium term, but it could have very negative implications for Chinese growth over the short term,” Charlene Chu of Fitch Ratings told Reuters. She described the repackaging of loans to be sold to investors as “one of the most disconcerting developments we’ve seen in the Chinese banking sector over the last decade.”

On the borrower side, the companies likely to be hurt the most are property developers. Since late last year, banks have been discouraged from lending to developers, which left trust companies as one of the few reliable sources of credit.

One economist told Dow Jones that it is not uncommon for real estate companies to borrow from trust companies at an annualised interest rate of between 15% and 20%. Another analyst told the newswire that as much as 20% of the sector’s financing could be trust loans.

The latest moves could also affect financial institutions outside China, as a number of foreign banks have bought stakes in trust companies. Buyers includes Barclays, Macquarie and Morgan Stanley, reports the Wall Street Journal.

Foreign banks have shown interest in the lightly regulated trust industry as a means to provide financial services outside of the constraints of the traditional banking sector, especially with regards to selling investment products to wealthy clients.

Now that the regulator is putting trust companies under increasing scrutiny, the rush to get into the industry might come to an end. And those foreign banks that have already bought in could find their their partner less free to make money than in the past.


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